Stone's Weekly Market Guide - Week of September 21, 2020
Chart of the Week: The transition from summer to fall and the recent market action made me think of The Byrds singing “Turn! Turn! Turn! (To Everything There is a Season).” Our analysis in early August looked at the late 1990s as similar to recent times with mega-cap and growth stocks outperforming smaller companies and value before a reversal of fortune in 2000 through 2002. As the song (and the book of Ecclesiastes) says, “to everything there is a season” and there was a rotation within the market starting in early September (see chart 1). While small-cap stocks (Russell 2000) have outperformed the S&P 500 since the March bottom, this outperformance reaccelerated at the beginning of September. Additionally, the equal-weighted S&P 500 began to outperform the capitalization-weighted S&P 500 (the widely quoted index), indicating better performance of the smaller companies within the index versus the huge companies. While both high dividend (Dow Jones Select Dividend index) and value (Russell 1000 Value and MSCI USA Enhanced Value indexes) strategies underperformed by a large margin year-to-date, both began to outperform as of September 1. But what does all this mean? The market is clearly starting to price in more conviction regarding a sustainable economic recovery. Smaller companies along with high dividend and value strategies consist of lower quality companies as defined by a lower return on equity and more debt relative to earnings (see chart 2). These companies typically have more leverage to a strong economic recovery and currently sell at a discount to the S&P 500. Our view remains that maintaining and perhaps rebalancing some exposure to value and non-mega capitalization stocks will likely serve investors well as “the time to weep” for these areas may have ended.
Week in Preview
· Geopolitical: With lockdown measures being re-introduced in parts of the globe to combat a resurgence in COVID-19 infections, the impact on economic activity will be closely monitored. Tensions between the U.S. and China will be watched for further escalation with the new TikTok deal seemingly on track, but the WeChat curbs remain in flux. The death of Supreme Court Justice Ruth Bader Ginsberg will make the election season even more contentious with the Democrats certain to go all out to block Trump’s replacement pick.
· U.S.: Housing continues to be a strength with August existing and new home sales likely remaining firm. September PMI readings should confirm the ongoing economic recovery and could give a better idea of the strength. After the Federal Reserve (FOMC) met with no change in rates as expected, there will be a large slug of Fedspeak to help clarify the policy framework. Fed Chair Powell will appear before the House and Senate this week to discuss the COVID-19 crisis response, joined by Treasury Secretary Mnuchin at times. Initial jobless claims will be watched closely this week for a high frequency read on the labor market though last week’s report was an improvement after some signs of slowing momentum in the job recovery. Readings for our U.S. Reopening Monitor held steady last week but initial readings on new COVID-19 cases rose on a week-over-week (W/W) basis for the first time in nine weeks. Improvement continues in the underlying high frequency economic data for transit, but some weakness is seen in the travel and dining indicators. Even though travel was down relative to the previous year, the total number of travelers rose on a W/W basis. The Atlanta and New York Fed’s estimate of 3Q GDP growth are 32.0% and 14.3%, respectively. Please see our U.S. Reopening Monitor and our Guide to the U.S. Reopening Monitor for more details.
· S&P 500 Earnings: Just seven S&P 500 companies are reporting earnings with Nike (NKE) and Costco Wholesale (COST) among the more interesting reports. As we forecasted, 2Q earnings showed large earnings declines but handily beat expectations and some companies have reinstated earnings guidance which is a positive in removing some unknowns. 3Q earnings estimates have improved and are expected to be less bad with consensus estimates of -21.8% and -3.8% year-over-year (Y/Y) decline in earnings and sales, respectively. The calendar year 2020 and 2021 earnings estimates improved again last week.
· Europe: Confirmed COVID cases have risen on a W/W basis for eleven straight weeks in the Eurozone and could weigh on the outlook. Infection growth moved higher again in Germany, while France and Spain are struggling with their highest weekly infection count ever. The U.K. pace of infections increased for the third week in a row after a couple of W/W improvements. September PMI readings for the Eurozone and the U.K. should continue to indicate economic growth but could moderate with the infection counts weighing on activity. The European Union (E.U.) trade ministers meet on Monday with a E.U. summit of leaders scheduled for Thursday and Friday.
· Asia: The economic calendar in China is empty this week. Japan has holidays on Monday and Tuesday, so it is a light calendar for the week. Japan has had six straight weeks of W/W declines in infections after a streak of increases. Japan September PMI readings could indicate some economic improvement after weak readings in August.
Central Banks: The central banks of Pakistan, Sweden, Hungary, New Zealand, Morocco, Nigeria, Thailand, Czech Republic, Switzerland, Norway, Turkey, Mexico, Egypt and Colombia are scheduled to meet with only Mexico and Colombia expected to cut their policy rate by 25 basis points (0.25%).
Week in Review
· Stocks declined by -0.6% for the S&P 500 with four out of eleven sectors higher for the week. Large cap value as measured by the Russell 1000 Value outperformed at 0.5%. Energy (2.9%), industrials (1.5%) and materials (0.9%) outperformed the S&P 500, while consumer discretionary (-2.3%), communication services (-2.3%) and consumer staples (-1.7%) were the biggest laggards. WTI (10.1%) and Brent (8.3%) oil were higher with MLPs (0.3%) and the energy sector (2.9%) outperforming. Small cap stocks outperformed relative to the S&P 500 with the Russell 2000 higher by 2.6% and small cap value stocks underperforming at 1.9%. The 10-year and 30-year U.S. Treasury yield were higher at 0.69% and 1.45% respectively.
· High yield credit spreads narrowed reflecting increased risk appetite. AAA municipal bond yields as a percentage of Treasuries fell, causing municipal bonds to outperform. The negative revenue impacts of the economic lockdown on local governments and talk of state bankruptcy have driven municipal bond valuations to low levels relative to Treasuries. Allowing states to declare bankruptcy should remain an unlikely outcome with the heart of the issue really about the size and distribution of Federal government aid. Additional support for the states is likely to come in any future stimulus bills.
· The U.S. dollar was weaker against both developed and emerging market currencies. Developed international stocks as measured by MSCI EAFE outperformed the S&P 500 returns in U.S. dollar terms (0.8%) and on a hedged-currency basis (0.0%). MSCI Japan outperformed the S&P 500 returns in U.S. dollar terms (0.2%) and on a hedged-currency basis (0.3%). Emerging market stocks outperformed the S&P 500 with the non-hedged return of 1.5% for MSCI EM.
· The 10-2 yield curve widened to +55 basis points. Another curve measure of three-month yield six quarters forward minus the current three-month yield rose to +8 basis points. The yield curve has historically provided an accurate forecast of future recessions when the difference in these measures turns negative, also known as inversion. Yield curves are one of the major indicators that we monitor to judge recession risk, but these inversions typically happen more than a year in advance of an economic recession but external shocks like the current coronavirus-induced recession might not be accompanied by one. Stocks have historically had significant advances post-inversion.
The PDF version of Stone's Weekly Market Guide is linked here.
The Guide to the U.S. Reopening Monitor is linked here.
The weekly update to the U.S. Reopening Monitor is linked here.